Income investing in a low interest rate world ain’t easy.
There aren’t many places to park your cash and earn a decent return these days. Many investors have turned to dividend growth stocks just to keep up with inflation.
And there’s one sector where the dividends are growing… in a big way.
And surprisingly, this sector and its profits are positively correlated with rising interest rates. Is confidence in its dividends an indication that interest rates are getting ready to go up?
Banking on Dividends
Over the last 12 months, more companies in the banking sector have raised their dividends 10% or more than companies in any other sector.
That’s seven times the number of increases in pipeline companies, the next-largest sector.
This is intriguing because large bank dividends have been hard to find since 2008.
After a record number of banks failed, the government stepped in with bailout money.
Some were saved, but most bank dividends disappeared.
And increased regulation in the aftermath of the Great Recession depressed dividends further.
Today, the big banks must pass annual “stress tests” run by the Federal Reserve. The tests are designed to ensure they’ll be able to survive another economic catastrophe. And to that end, they’re also required to hold more capital on their balance sheets.
Building these reserves left the banks with even less money for dividend payments. Instead of focusing on shareholders, they worked to restore consumer confidence.
But over the last few years, conditions have improved. Today, the banking industry is in the midst of a dividend resurgence.
Many started by initiating small dividends or token raises. And this year, the Fed-approved jumps have been in the double or even triple digits.
For example, Citigroup (NYSE: C) increased its quarterly dividend by a whopping 220% in July, from $0.05 to $0.16 per share. And earlier this month, Citigroup CFO John Gerspach said the company recognizes the importance of future dividend raises.
Investors should view the number and extent of these increases as a sign of confidence.
They signal that both the Fed and the banks see bigger gains for the industry ahead. And although the Fed said [Wednesday] that it would be slower to raise rates, future increases are on the table.
A Bigger Interest in Dividends
And when rates do go up, the banks’ dividends will be set to take off.
Regional banks, especially, will be some of the biggest beneficiaries of higher interest rates because they’ll make more money on loans. The “spread,” or the difference between the rate banks charge on loans and the rate they pay on deposits, will widen.
And when the Fed raises rates, the interest on loans will rise at a faster pace than the interest on deposits. So bank profits will go up.
Rising interest rates are good for banks… and their dividends. The banks know it, and the Fed knows it too.
Rapidly rising bank dividends imply the era of near-zero interest rates may be ending soon. And although the Fed didn’t raise rates yesterday, rising bank dividends mean that it could happen sooner than many believe.
Although it seems unlikely today, a December rate hike is not off the table. And it may be just the beginning. In the meantime, keep an eye on bank stock dividends.
Source: Wealthy Retirement